Unbelievably, too many boomer parents still save for college with taxable vehicles. Advisors need to steer them toward tax-advantaged accounts - like 529 plans.
Parents know a college degree is important for their children. They know it holds the key to a better career, a better future. A recent Country Financial College Trend Survey asked parents the following question: "Given the rising cost, is college still a good financial investment?" Eighty-one percent of survey participants said yes. Country Financial's survey then asked, "Do you use tax-advantaged savings vehicles to save for your child's college education?" More than 70 percent responded no.
Advisors are living and working in a world where parents have created a serious disconnect. How can that be? Why do eight out of 10 parents say college is a good investment but only three out of 10 use tax-advantaged vehicles to save?
"There are a lot of good intentions out there, but the execution is poor, says Joe Buhrmann, manager of Country Financial's Country Advice Center. "There's a lack of planning. People are buried by the number of choices out there. There are plenty of things competing for their checkbook."
One of those things competing for boomers' money is the 529 college savings plan, a tax-advantaged, income-limit-free savings tool meant to make college attainable for children at any economic stratum. More than 10 million of the accounts have been opened nationwide, and more than $130 billion in assets populate those accounts. Even 529 proponents know the plans can't be viewed in a vacuum - "They aren't the end-all, be-all," says Jay Murray, president and founder of Denver-based Solutions for Tuition - but they should be considered, and they should be considered in the right light.
Advisors, to best help their clients, need to know what to look for in a solid 529 plan and what questions parents are going to ask so they can be armed with the correct answers. And, advisors need to remember that college savings plans have to fit into the larger picture of retirement and estate planning. The college-bound student isn't the only one stuck with homework - advisors and parents have some, too.
Fortunately for advisors, selecting a 529 plan for a client allows the financial professional to act and think as an advisor. The same components that make up a good mutual fund or other investment vehicle factor into a solid 529 plan.
"A lot of it comes down to investment options, the fund manager, and fees and expenses," says Joe Hurley, founder of Savingforcollege.com based in Pittsford, N.Y., and vice president of Bankrate Inc.
Advisors are used to that. They make decisions for boomers every day while considering just those factors. And that's important when it comes to choosing a 529 plan, because it isn't as simple as putting a family from Iowa into Iowa's 529 plan or plans. Consumers can put their funds into any state's 529 plan and still realize the benefits. Where advisors have to be careful is with state-specific incentives, like tax deductions and credits.
"As a financial advisor, they get to do what is best for the client," says Jackie Williams, executive director of the Ohio Tuition Trust Authority, based in Columbus, Ohio. "If you're going to sell another state's plan, you better have sound reasoning. Any benefits offered by the home state must be offset by the out-of-state plan's performance."
Does slightly better performance outweigh a tax credit? Does the tax credit make the homestate's plan competitive? What does the client think? What does the advisor think? These are all questions that must be considered by advisors.
To help advisors, Savingforcollege.com compiles a quarterly list of the top-performing plans in both the direct-sold and broker-sold arenas. On the broker-sold side, the following were the top 15 performing plans ranked by one-year performance, including max sales charges (Class A), for the period ended March 31, 2008:
- Arizona: InvestEd Plan
- Nebraska: College Savings Plan of Nebraska
- Virginia: CollegeAmerica
- District of Columbia: DC 529 College Savings Program
- Iowa: Iowa Advisor529 Plan
- Illinois: Bright Directions College Savings Program
- Mississippi: MACS 529 Advisor Program
- Alaska: John Hancock Freedom 529
- Maine: NextGen College Investing Plan - Client Select Series
- Oregon: MFS 529 Savings Plan
- California: ScholarShare Advisor College Savings Plan
- West Virginia: The Hartford SMART529
- South Dakota: CollegeAccess 529
- Wisconsin: Tomorrow's Scholar
- Indiana: CollegeChoice 529 Investment Plan
Like any investment product, a 529 plan shouldn't be ignored once the sale is complete. It's a big investment parents are making, and it should be treated that way.
"There is a big difference in [plan] performance," Murray says. "Advisors need to do their homework on the front end, and they need to monitor the plans on the back end."
Concerned parents are bound to have lots of questions, and advisors with the most comprehensive answers will come out ahead. What are the most common questions experts are hearing, and how do they answer them?
One of the biggest questions is, "What if my child doesn't go to college?" Options vary on this. If the parents have other children, they can change the beneficiary on the plan. They can even name a niece or nephew as the beneficiary without penalty. If one of the parents has always wanted to attend graduate school, that parent can be the plan beneficiary and use the money for school. Hurley says a longer-term scenario is to let the account keep growing and change the beneficiary to a grandchild years down the road. Otherwise, they are going to pay ordinary income tax and an early-withdrawal penalty, much like with an IRA or 401(k).
Another popular question: "What if my child gets a scholarship?" First off, not many do. If an athletically or academically gifted student does get that coveted scholarship, says Murray, "most states allow parents to withdraw the value of the scholarship without penalty. They will pay income tax but no penalty."
"What if my child goes to a trade school or a proprietary college?" Well, says Buhrmann, "the funds can be used at nearly any institution that qualifies for federal financial aid assistance." Any accredited school is approved for 529 funds, not just large state and private universities.
As the number of schools that meets the 529-specific requirements expands, so, too, does the advisor's chance to place people in the tax-advantaged accounts. Ten million accounts sounds like a milestone, but it represents a fraction of the number of college-bound students over the next 20 years. Buhrmann says it is an untapped market. According to Country's survey results, parents know college is a good investment and they know they should start saving earlier rather than later, but it's up to advisors to get them interested. Procrastination seems to be the enemy.
"Part of the challenge is getting families to open an account," Williams says. "Once one is open, you need to set up a system for contributing to that account," whether that is through electronic transfer or getting in the habit of writing a check on the same day every month.
Two other attitudes get in the way, too. The first, as Buhrmann sees it, is getting parents to realize that college is an investment and not a cost. "Every dollar needs to count," he says. "To miss out on the advantages of a tax-advantaged plan is damaging."
And many parents are missing out, according to Hurley, because of the second incorrect attitude: They are stuck with old-fashioned savings mentalities.
"Advisors have to realize a lot of parents are still saving in taxable accounts," he says. "With tax rates expected to go up, there is even more advantage to saving in 529 plans."
As Murray said, 529 plans are not the only solution; they are part of a solution for the right families. So much planning and decision-making goes into picking a plan that fits, not only with a family's college aspirations but also into the overall financial plan - including retirement. Once advisors understand which plans are performing well and how to help parents find the answers to their questions, they need to understand how college savings plans affect financial aid formulas and a student's ability to secure grants and loans. More homework, and a story for another time.